John Moffatt: Here Comes the Fed
Alex Seagle recently introduced me to John Moffatt of Analytic Systems, so this is the first time that I have seen his interesting and informative letter. Here is a brief sample on the US economy
Government officials are trying to stimulate the US economy until it returns to normal. With the loss of goods producing jobs (from over 30% of the total in the 1970's to less than 14% recently) and other effects of globalization, one might ask what is normal. In the last cycle, growth was achieved by high levels of debt aided by soaring residential real estate prices. Excluding the increase in debt, growth was minimal. As the private sector deleverages and globalization is in full force, the US economy may be able to grow only at 2 - 2.5%, which is in line with those who have been discussing a "new normal". At that rate of growth the unemployment rate is likely to stay quite high for a protracted period of time. Not only is a high unemployment rate politically unacceptable, a low growth doesn't allow the US to outgrow its increasing debt burden. While politically difficult the US needs to retrench and cut back entitlement spending. There is not enough room to cut spending in a meaningful way unless entitlements such as Social Security, Medicare and Medicaid are included. The private sector has adjusted to the forces of globalization, foregoing wage increases and become more productive, whereas the public sector has become bloated, inefficient and overpaid on a relative basis.
Never before has the outlook for budget deficits been so large for so long with the exception of World War II. Financing those deficits over the next five years appears to be beyond the scope of anything that has ever been accomplished. Recently forays into longer maturities of Treasuries have been met by relatively poor receptions. What does that say about the ability of the US government to finance a rising debt obligation when the economy resumes more normal growth and inflation displaces current fears of deflation?
And another on sectors:
It's times like these when the ASC model is helpful. Let's look at what it's telling us. The five highest and lowest ranked groups offer some insight. The five lowest ranked groups are: Rails, Steel, Aerospace, Processing and Trucking. The five highest ranked groups are: Computer Service, Telecom, Appliances, Housing and Hospital Supply. We think that the foregoing indicates that market action in these groups, good or bad, is signaling a change in leadership. Market action is telling us that the leadership groups whose positive earnings outlook were based upon the belief that the US was experiencing a V shaped recovery in which earnings would recover faster than expected and which might result in a bout of inflation if policy makers were not timely in their withdrawal of excess liquidity from the economy. Also implicit in their strategy was confidence that Europe and China would lead the US out of recession and into the next growth cycle. However, investors appear to be questioning the assumptions that previously convinced them to buy these groups. In recent weeks the certainty surrounding the economic well being of Europe and China has been undermined. We have spent a lot of time discussing our concerns regarding investor complacency when it comes to the risks we see in many areas from real estate to the bond market and now it seems others are beginning to react as well.
During the recent correction, the groups that were hit the hardest were commodity related and energy. If we expand the population of groups we are considering to include the bottom half of ASC's rankings we see more evidence that the investment environment is changing or perhaps has changed to the point where the groups that made up the market leadership for the past six months have started to give ground: Energy is 29th, Chemicals are 31st, Retailing is 32nd, Coal is 34th, Papers are 35th. Investors appear to no longer be willing to bet that we will see a V shaped recovery or that liquidity can be withdrawn without mishaps occurring.
Where might we find the new leadership? Looking again at the top half of the group rankings we see the likes of Electronics, Technology, Natural Gas, Commercial Banks and Hospital Management. The ASC Model is placing more value on consistent growth and dividends of companies that are not so dependant on a normal economic rebound. Investors want companies that can prosper in a 'New Normal' economy.
David Fuller's view I think these are good summaries and recommend that subscribers read the full issue.
John Moffatt will also be speaking at the Contrary Opinion Forum in October.